JPM, MS On Reviving Synthetic CDOs: Never Mind

By Michael Aneiro

A couple of weeks ago this blog wrote about how banks, struggling to boost fees and investment returns in a post-crisis era of low bond yields, had come full circle back to an idea that helped create the crisis in the first place: synthetic collateralized debt obligations. Specifically, JP Morgan (JPM) and Morgan Stanley (MS) had been reported to be planning to reintroduce these derivatives.

Not so fast, it turns out. Tracy Alloway, Tom Braithwaite and Dan McCrum report in the Financial Times that the two banks have abandoned their plans after investors balked:

Bankers at the two Wall Street firms were looking at reviving synthetic CDOs, which were criticised for adding to losses during the financial crisis, after receiving inquiries from some investors hungry for higher yielding investments.

Synthetic CDOs pool derivatives known as credit default swaps and then divide them into different pieces, or “tranches,” with varying levels of risk. The deals allow investors to make amplified, or leveraged, bets on the underlying loans or bonds….

The two banks’ difficulties in selling a complex synthetic CDO highlight how the Wall Street landscape has changed. Bankers once manufactured the deals on an industrial scale. Other banks and monoline insurers such as AIG often bought the top senior slice, effectively selling credit protection on the underlying loans or bonds. Now many of the traditional buyers of the senior tranche have disappeared.